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Ok. Got itRussia’s invasion of Ukraine has had tough economic and financial consequences for the global economy.
February was a volatile month for markets. Concerns that hawkish central banks could dampen prospective growth in their efforts to curtail inflationary pressures dominated in the first half of the month, but was rapidly replaced when Russia invaded Ukraine. While risk assets suffered under the uncertainty of geopolitics, commodities rose to reflect the potential supply disruption and future scarcity.
Global equity markets declined across the board, with European bourses impacted most. The DAX lost 6,3%, bringing the year-to-date decline to 10,1%. The S&P 500 lost 3,0% in February, even with the backdrop of credible quarterly earnings results from US corporates. The technology-heavy Nasdaq 100, bore the brunt of the negative momentum from frontloaded interest rate expectations, losing 4,5%. Emerging markets also lost ground, with the MSCI Emerging Markets Index declining 3,0%, with commodity-producing countries offering some ballast against the risk off environment. Exposure to energy and mining helped UK markets, with the FTSE 100 holding up at 0,3%. The MSCI World Index declined 2,5%, bringing returns over the past 12 months to 11,2%.
Commodity prices rose on geopolitical tensions, with energy markets becoming both the epicentre of inflationary risk and a geopolitical pinch point.
At their February meeting, OPEC+ members chose to stick with the gradual increase in production rather than ramping up production in the face of increased demand and higher oil prices. While some countries have released strategic oil reserves since the intensification of the Russia-Ukraine conflict, this has done little to stymie price momentum. The price of Brent crude oil ended the month at around $100, a 30% increase from the start of the year, while European natural gas prices rose on average 15% over the month.
The Bank of England increased rates by 25 bps in a vote of 5:4, with the four votes supporting a 50 bps increase. The ECB kept rates unchanged but expressed far greater caution than in the past, acknowledging an inflation print of 5,1% in January, which exceeded expectations. In the US inflation also edged higher, heightening expectation of even tighter monetary policy.
Global bond markets traded under pressure as bond yields rose to reflect a more hawkish sentiment, only to fall back on dampened growth expectations as geopolitical tensions intensified. The US 10-year bond yield exceeded the 2,0% level for the first time since 2019 by mid-month but ended at 1,8%. Markets are now placing a higher probability on a recession in a few years from now. In US dollar terms, the Barclays Global Aggregate Index declined by 1,2% in February.
The impact
While the situation in Russia and Ukraine remains fluid, the immediate pressure points for the global economy were quickly revealed. Russia represents a small part of global equity markets and on average makes a modest contribution to global economic growth, although many global companies have operational exposure to Russia and Ukraine where the impact of current events could be felt. However, the broader and more significant impact is via supply chains, global trade, commodities, and the impact of sanctions. The clearest transmission is currently via the energy market and related prices. Russia is a major commodity producer and contributes more than 10% of global crude oil and more than 15% to global natural gas production. Other significant commodities affected by this conflict include wheat and palladium, which could impact the auto industry and food prices. A significant component of Europe’s energy imports come from Russia, and their well-documented reliance on Russia’s supply of natural gas poses a region-specific inflation and growth risk.
Policymakers face a challenging backdrop, with soaring energy prices adding to inflationary pressures, while that same trend, alongside increased interest rates, could well lead to lower activity and economic growth. The risk of policy mistakes or misjudgement has risen, and the markets are taking note.
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